Do you think that the amount you sell for certain items is your earnings? The answer is no, earnings are not so straightforward, you have to make some calculations to derive the value of your earnings.
You have to get your earnings numbers down so that you can analyze if your business is doing well. You can be making tons and tons of sales, but your earnings may be so little that it barely covers your cost of production or services. This is why you should understand how earnings work so that you can monitor your business better.
How to Calculate Earnings?
Earnings = Gross Profit – All Expenses
Gross Profit is derived from deducting your cost of sales from your sales revenue, meaning that you are using the selling price to minus away to cost price. This gives you the profit of the product sales, but you have to take into account that running businesses incur other expenses such as utility bills, wages and salaries, and marketing expenses.
Only by using your profits to minus off all your expenses then you will get your true earnings. You can then use the amount to track the performance of your business.
What is EPS
Earning Per Share (EPS) can be used to determine if a company is worth it for you to invest in. EPS can be calculated using their earning divided by the outstanding shares that are of common stock. The higher the EPS, means the better the company is performing and this interprets that the company is a good potential investment.
Limitations of EPS
There are ways in which companies can do to improve their EPS. One example is that companies are able to purchase back their outstanding shares. Using Math logic, you would realize that the EPS will increase as the company has fewer shares that are outstanding. Other than that, since EPS is often calculated using income statement numbers, you cannot tell if the company has lots of debts. If the company has a lot of debts then, the earnings might not be that valuable anymore as they are not managing their finance well and this could mean a bad investment.
What is PE Ratio?
Price-to-Earnings (PE) Ratio is used to assess if a company is being overvalued or undervalued in the stock market. You can calculate the PE Ratio by dividing the price of the share by the earnings per share. Generally, if you are trying to assess if a company is worth your investment, you would want to go with the ones with a lower PE Ratio, it means that the company is not being highly expected to do well and they are more likely to outperform other companies which allows you to gain more from the investment. On the other hand, having a high PE Ratio just simply means that the shares of the company are in demand and a lot of investors are expecting it to have good growth.
Limitations of PE Ratio
The first limitation of the PE Ratio is that the number does not tell you about the growth of the company in terms of their revenue and earnings in the future. These simply tell you that the PE Ratio does not really help you in determining if a company is growing well as there are more factors to consider such as the trades the company is making, is it cheap or expensive.
Other than that, PE Ratio can be misleading. If people are going after the cheap stocks because of the PE Ratio, this can be a mistake. There should be a reason why the stock is cheap and why no one is picking them up. So this means that you have to be more careful and ensure that you take multiple data and numbers to analyze a company before investing.
Why Should You Care About Earnings?
From a company perspective, you have to understand how much you are earning as it would determine the health of your company. This takes into account how your company is able to earn how much money even though you put in some money to produce the goods, market the good and other costs incurred in the process of preparing it for selling.
From an investor standpoint, you have to know the earnings of a company to understand how the company is doing. This would then gives you a rough understanding of the company being a good or bad investment before you gamble your money away. This allows investors to make smarter decisions and have more data to study before investing.
